On Wednesday, Unity Software Inc. (U, Financial), a company offering a platform for video game software development, announced an agreement to acquire app monetization company ironSource (IS, Financial) in an all-stock deal worth $4.4 billion, representing a 74% premium to the stock’s 30-day average price.
According to the announcement, the “transformative” merger will create the “industry’s first end-to-end platform to power creators’ success as they build, run, manage, grow, and monetize live games and real-time, 3D content.”
Following the news, ironSource’s shares soared nearly 50%, gaining another 4% on Thursday to trade around $3.42 apiece for a market cap of $3.46 billion. Even after the gains, the stock is still trading substantially below the $4.4 billion valuation mark.
However, since it is an all-stock deal, we also have to consider Unity’s stock price, which dropped 13% on Wednesday before opening roughly flat on Thursday for a share price of $32.96 and a market cap of $9.80 billion. With this factored in, the market has already fully priced in the deal.
While some big names like Catherine Wood (Trades, Portfolio) and Sequoia Capital seem positive on the deal, and Unity itself is naturally promoting it as the next big thing, I think this could turn out to be a prime example of what Peter Lynch would call “diworseification,” also known as diversification that makes a company worse instead of better.
Game developers are not impressed
Following the announcement of the merger deal, many game developers who use Unity’s engine took to the internet to vehemently express their scorn. In a rare turn of events for an M&A deal, the majority of the top-ranked articles on Google (GOOG, Financial)(GOOGL, Financial) about the subject were written by or for Unity’s displeased customer base.
One of the highest-ranked articles was by Jody Macgregor on PCGAMER, titled “Unity is merging with a company who made a malware installer.” Indeed, aside from its main app monetization business that the company entered after merging with Supersonic in 2015, ironSource is infamous for developing InstallCore, a software installation bundler that plagues PCs with unwanted toolbars, junk and adware.
For game developers using Unity’s engine, it is vitally important the owners of operating systems trust the company to not bundle bad things along with games. A breach of that trust could be trouble for the entire Unity ecosystem.
Game developers are seriously questioning whether Unity has its head on straight. At first glance, this seems to be a case of putting profit over the quality of the product, but even that might be too generous because the company already has its own monetization platform, Unity Ads.
According to Unity, "Unity and ironSource's complementary data and product capabilities will give creators access to better funding for user acquisition (UA) and monetization to successfully scale their games and accelerate their economic performance."
However, is that really worth $4.4 billion? Unity has been on an acquisition spree lately, but whereas its previous acquisitions were focused on product quality, this one is focused on a monetization method that its developers intensely dislike.
Sacrificing product quality
In part to help fund this acquisition, Unity recently laid off hundreds of employees to “realign some of our resources,” which could be an example of sacrificing product quality for profit. While this can sometimes be a successful strategy for businesses, it is known to backfire frequently in the tech world, where product quality is the biggest moat a business can have.
“The general mood at the company is that the whole company, at this point, has been horrifically mismanaged,” an anonymous former employee told Kotaku.
While the acquisition could help bolster Unity’s flagging bottom line in the short term, both the acquisition spree and cutting down on its own employee base indicate the company has started looking outwards for growth at the expense of organic growth.
Unity showing weakness
Part of the decline in Unity’s share price is likely due not to the acquisition agreement, but rather to the company’s reduction in guidance posted on the same day.
Citing an unfavorable macro environment and a competitive monetization dynamic, Unity reduced its full-year 2022 revenue guidance from $1.35 billion to $1.42 billion to $1.3 billion to $1.35 billion.
In a situation where its own fundamentals are weakening, Unity is aiming to bolster its results with those of a former malware company that has made excellent progress in recent years, growing its Ebitda by 49% year over year in the first quarter of 2022, though its earnings per share were down.
Big-name investors backing the deal
Despite Unity’s customers and employees not being too keen on the deal, there were some notable institutional investors backing it up.
Existing investors Sequoia Capital and Silver Lake said they would invest a combined $1 billion when the deal closes.
Catherine Wood (Trades, Portfolio)’s ARK Invest reportedly bought another 1 million Unity shares after the acquisition deal was announced, causing the share price to slump. According to Ark’s second-quarter 13F report, which was filed just a few days before, Wood added 931,488 shares to the position in the second quarter for a total stake of 9,175,711 shares, representing 3.10% of Unity’s shares outstanding.
Wall Street is also bullish on the stock with sell-side analysts assigning it 11 buy ratings, five hold ratings and two sell ratings.
Takeaway
While certain institutional investors and Wall Street are positive about Unity’s decision to acquire ironSource, I think it is telling that there has been such an outcry from the company’s customers and employees.
From a monetization standpoint, it is possible this deal could work out for the company over a time horizon of a couple of years, but that hinges on whether Unity can rescue its organic business from decline rather than just tacking on acquisitions that may or may not be worth the cost. It would need to accomplish this despite a greater focus on advertising rather than its development platform.
